Is Latin America Blowing It? The Case of Chile

The present period could be called the best of times for Latin America. The China-commodity boom since 2003, the overall strength of global trade, and the reduced cost of foreign loans are a welcome respite from the late 1990s patterns of “sudden stops” and attendant turmoil.

Despite the external improvements, a feeling is widespread in Latin America that this bonanza is being wasted and that the economic growth performance (GDP growth averages about 4%) should be much better than it is. It seems as though no news is really good news for a region which coined the term “fracasomania” : as failure is the norm for Latin America, its eventual appearance is always anticipated.

The reasons for relative pessimism about Latin America today vary from country to country, but these include a dread of creeping Dutch disease (which will undermine competitiveness) and the reality of wasteful spending by governments flush with funds and anxious to bolster ratings. Even with the wind so clearly at their backs, Latin governments stand accused of being too timid to take on the really tough economic reforms (e.g., of taxes and foreign trade) that might actually improve growth in the long run.

Roberto Rigobon, in his insightful reflection on the blissful (naïve?) euphoria of foreign investors looking at Latin America, challenges us to think of a single Latin American economy that truly is “outperforming”. Isn’t it true, he asks, that all of Latin America (with the possible exception of Peru) is blowing a rare opportunity to grow and develop much faster?

While the case is not airtight by any means, and the data on which it is based fairly recent, copper-rich Chile could be just such a case. Let’s look at it.

Until recently, all was not well in Chile. The private sector and the political parties (including the President’s own) were grumbling about the new Bachelet government’s economic and social policies and the mediocre (by Chile standards) rate of economic growth. But things may be changing for the better in Chile, and that may be a harbinger of what may be happening with a lag in other Latin countries.

The Chilean economy in the last three or four months seems to have kicked into a higher gear. The April index of economic activity (see Chart 1) surged 6.7% (s.a., year-on-year), the third consecutive monthly acceleration in growth. Meanwhile, the accumulated trade surplus in the first five months of the year is above $13 billion amid signs of strong growth in exports in general, including copper and non-copper exports. (Chart 2) Imports are also surging with intermediate goods and capital goods increasing by 30-50% over year-ago levels, a sign that productive capacity in Chile is also on the rise, a good sign for future growth.

In recent years, the major rap on Chile has been its disappointing employment performance with unemployment levels stubbornly high, weak job creation, and a relatively high proportion of the population below the poverty line. The most recent three-month period suggests that the labor market is beginning at last to respond. The unemployment rate, for example, has fallen almost 2% from a year ago to 6.8% and job creation is up. Poverty levels are trending downward.

Chile is reaping these improvements without any weakening in its economic policies which have won worldwide admiration. Inflation is under control (less than 3%, though the Central Bank stands poised to raise rates) and fiscal spending has been kept under control by a vigilant Finance Ministry. The nominal Chilean exchange rate has strengthened somewhat against the dollar, true, but Chile has avoided any substantial real appreciation of the currency, partly through channeling fiscal savings abroad.

Finally, an important change in policy occurred recently, one that might help translate some of the growth momentum (assuming it is sustained) into real economic development that raises productivity and living standards as well as incomes. President Bachelet in her annual address in May announced a modification in Chile’s long-standing “structural budget surplus” target of 1%. The fund, which is now in excess of $7 billion, is fed in good times by a 1% “structural budget surplus” rule meaning, simply, that any net fiscal revenues in excess of 1% of GDP are put away into the fund. (Last year, the overall fiscal surplus reached almost 8% of GDP and this year another large surplus is expected. See Chart 3.) Bachelet announced that the structural surplus target in 2008 would be reduced from 1% to 0.5% of GDP which means, concretely, that Chile will spend an extra $750 million on education (and other priorities) next year over and above what had been budgeted. Education is one of the areas in which Chile has lagged badly behind the developed world; it may now have more resources with which to catch up.

It might be pointed out that President Bachelet has plenty of short-term political motivation to tap into the fund now, principally her falling approval ratings and pressures from her own political party to boost spending. At the same time, the Finance Ministry was able to argue convincingly that easing the fiscal structural surplus goal made a great deal of sense given Chile’s reduced financial vulnerabilities. In this case, political expedience and fiscal prudence are not in conflict.

This little Chile story may strike some readers as old hat: We all know that Chile has performed better than other Latin countries for a long time. Its success right now does not mean that Brazil, Colombia, Uruguay and all the others will likewise convert the present external bonanza into the basis for a long-term boost in growth.

But at least in this one case of Chile, we should not give in to fracasomania just yet.

7 Responses to "Is Latin America Blowing It? The Case of Chile"

Vitoria Saddi June 20, 2007 at 2:48 pm

Tom, I couldn’t agree more with the key points you make about Chile and more broadly, that it is too early to call (like the 80s) ‘mania de fracasso’. Still, my question remains: do you think it is feasible for us to see Brazil in a better position than now? “Why isn’t the whole world rich?” was the question that I intended to answer when I became an economist. But even if you place this question to Latam do you think it is possible for the a significant improvement in the whole region? Remember, Chile’s GDP = RJ+SP; Peru’s GDP=Parana

JohnH June 20, 2007 at 5:15 pm

Wow! Chile finally made it to 6.7% GDP growth three years after the copper resource boom started. I’m impressed (not!). Maybe if the government would adopt some social programs and redistribute income (poorer segments spend instead of sending money to Miami), the economy would grow at 10%, like Venezuela’s.

bsetser June 21, 2007 at 10:19 am

I think John raises (implicitly) an important point. Right now the received wisdom is that it is wise and prudent for a government not to spend a commodity windfall domestically. There is too much of a risk of generating dutch disease via real appreciation, and too much of a risk of setting a level of expenditure that can only be sustained if commodity prices are high. both good points — particularly if a commodity price shock is temporary. But the net result is that a commodity windfall generates far more obvious benefits for international financiers — who take the funds “liquidity” that commodity exporters dump into the international financial system as they build up commodity funds and use them to lever up in various ways — than for the residents of the commodity exporting economies. Blackstone gets a source of liquidity/ big immediate gains, Chileans get — more assets that could help to cushion a future downturn, which is worth something, and perhaps a lot — but few immediate and visible benefits … and from the point of view of global adjustment, if all commodity exporters treat the commodity windfall as a temporary shock and increase savings rather than increase spending, at a global level the commodity exporters are in effect assuring the continuation of the world’s imbalances — as they provide good chunk of the “uphill” capital flow. that no longer seems to the case — most oil exporters are now treating the shock as permanent and increasing spending. but it does seem at least to me that the received wisdom on how to respond to commodity shocks (all stabilization fund, no spending) needs to be reconsidered, and some innovative ways for injecting some of the windfall into the domestic economy (while avoiding commitments that cannot be sustained over time) should be considered. A copper dividend? an oil dividend?

Anonymous June 21, 2007 at 12:34 pm

Here is Molano’s take on Chile, a little more cautious than your view especially on the political outlook and the weakness of the Bachelet presidency. Chile: Mid-Year Update by Walter Molano Chile is benefiting from the changes in the global economy. The commodity boom is translating into higher copper prices, boosting the levels of economic growth and government revenues. The Chilean economy should grow more than 6% y/y in 2007. At the end of the first quarter, Chiles unemployment rate fell to 6.7%–the lowest level in nine years. The fiscal impact from the increase in copper prices was even more impressive. The Chilean government posted a fiscal surplus of $11 billion in 2006, with Codelco contributing $9 billion to the bottom line. The fiscal surplus at the end of the first quarter of 2007 was $3.7 billion, putting the government on track for an even-larger windfall in 2007. Chile is impressive, sporting world-class infrastructure and institutional stability. Unfortunately, Chileans are far from content. President Michelle Bachelet is under fire, and she is trying to reinvigorate her administration. On May 21, President Bachelet gave her second state of the nation address. One of the highlights of her speech was a modification of the so-called Structural Fiscal Surplus rule. The rule was introduced in 2000, as a way to regain investor confidence. Chiles fiscal accounts eroded during the latter half of the 1990s and the government hid the damage by obfuscating the results. The new fiscal rule worked well, and the public sectors performance improved dramatically. However, an increase in copper prices provided an additional windfall, leaving the government with too much money. Now, it is trying to spend some of the excessparticularly by boosting expenditures in health and education. President Bachelet announced that the surplus target would be reduced to 0.5% of GDP in 2008 from 1% of GDP. The measures will allow the government to increase spending by $750 million. Of the total increase, $650 million will be directed towards education. Finance Minister Andres Velasco said that the additional funds will be used to improve the quality of Chiles academic programs and create a new agency, the Superintendency of Education, which will set national standards. Despite the presidents promise to improve public services, Chileans were skeptical. A survey conducted after the televised speech showed that 45% of the respondents doubted that the president would deliver on her promises. The response was worse in Santiago. President Bachelet is suffering from several noticeable setbacksmost of which occurred prior to her assuming office. The introduction of Transantiago, the new integrated public transportation system was a disasterwith too few buses, the absence of dedicated lanes and serious software glitches. Now, the cold winter in Argentina is adding to the presidents woes. With the coldest May in more than 130 years, and an over-stretched energy system, the Argentine government is forcing Chile to bear the brunt of the crisis. Argentina halted gas exports to Chile in order to prioritize its own domestic demand. To make matters worse, drought conditions in Chile are putting a strain on the countrys hydroelectric generating plants. Chilean electricity producers are raising prices in an attempt to control demand, and benefit from the situation. The Chilean government is also taking steps to reduce the countrys dependence on Argentina by importing Liquid Natural Gas (LNG), building new hydro-electric plants and perhaps nuclear reactors. Chiles macroeconomic conditions are sound, but the political environment is tense. There seems to be a power vacuum in Santiago. Chile has a long tradition of strong leaders and President Bachelet does not fit the mold. Perhaps, former President Lagos knew this all too well when he endorsed her candidacy. It could have been a way to highlight his own legacyan administration that was rife with corruption, bereft of economic reforms and which was ultimately saved by an unexpected rally in copper prices. Whatever the case, Chile is a prosperous country. But, its leader has an approval rate of only 40% and two more years in office.

Tom Trebat June 25, 2007 at 3:10 pm

I am appreciative of the comments posted to my assessment of the outlook for Chile. The general point people are raising is with respect to Commodity or National Stabilization Funds (NSFs). Columbia economists Sachs and Stiglitz have just published an interesting volume on the Resource Curse which, while concerned mainly with petroleum exporters, helps us to understand more about the value and limitations of these commodity funds. It seems to me that the NSF in Chile has been a huge success, one to be emulated throughout Latin America (Venezuela has tried as have others) as a good way of dealing with the political economy of booms and busts in commodity prices. Chile has used the fund to solidify the idea of fiscal institutions avoiding the perennial Latin American problem of pro-cyclical fiscal behavior: spending wildly in good times, then having to cut back fiscally when external prices turn adverse, thus aggravating downturns. It is interesting to contrast Chile with Venezuela, as several of the commmentators have done. Does Venezuela’s fiscal activism (for want of a better word) and higher rate of GDP growth mean that Chile is being too conservative? Is it better to redistribute the windfall (or as much of it as possible) immediately through cash subsidies and social programs to the poor? I think that what matters is how fiscal institutions and fiscal decisions affect growth in the long-run, not in any one year. Along these lines, the record clearly favors Chile. Twenty years ago, for example, Chile’s per capita income (ppp basis) was far lower than Venezuela’s: about $6500 to $8800. Fastforwarding to 2005, Chile’s per capita income had increased to almost $12,000. Venezuela’s had stagnated at $8800, the same as 20 years earlier. I do not think the more recent data, or human development indicators either, would substantially change this pattern. What does this tell us? Transparent fiscal institutions permitting steady increases over time in government spending – the Chile approach – might be important for growth in the medium-run than the attempt to use windfalls quickly to affect growth.

Anonymous July 18, 2007 at 9:09 am

Wow! I really appreciate most of the commetns posted on this blog. I am chilean and, as most of the people living in this country, I care a lot about our domestic economy. I think that what has been done with the huge amount of money earned by copper exports is very interesting and I hope that we could find a way to expend it in a good way. In my opinion, we must make another effort to improme our State’s efficiency and take our education standards into another level. Saving a lot of money in may be difficult… but spending it correctly can be really tough. Thanks!

Guest October 8, 2008 at 10:37 am

I’m a little surprised the Chilean government doesn’t cut taxes a little. I understand the VAT rate is about 19%, which seems very high to me, and the maximum tax rate on personal income is 40%.